Under the current Republican leadership, US banks have enjoyed some deregulation – but should a Democratic Party administration takeover after 2020's elections this could change dramatically. Justin Pugsley reports.
What is happening?
At an April 10 hearing held by the US House of Representatives Financial Services Committee, a considerable degree of hostility was shown towards US global systemically important banks (G-SIBs) by the Democratic Party, who have dominated the house since the mid-term elections. For example, phrases such as “too big to fail is too big to exist” were bandied about by Democrat committee members. This suggests that should the Democrats win power in the November 3, 2020 elections, the more bank-friendly regulatory environment under the Republican administration of US president Donald Trump could change markedly.
Indeed, it is a very different atmosphere from when Republican Jeb Hensarling chaired that committee and was promoting his bank-friendly Financial Choice Act. His replacement, Democrat Maxine Waters, takes a very different view on the largest US banks, and the CEOs of seven of these institutions were called in for a near six-hour grilling by Congress.
Questions from the Democrats were around financial inclusion, consumer protection, employee diversity, small business lending and ‘too big to fail’ issues. The Republicans, by contrast, focused on potential systemic risks, such as from shadow banking, while doing their best to emphasise the strength of the US banking system.
Why is it happening?
It is over a decade since the 2007/08 financial crisis and clearly there is still a great deal of anger in the US over the bail-outs of the big banks. Also – like many other Western countries – the US political system has become highly polarised, with the Democratic Party appearing to be leaning further to the left and many of its members deeply suspicious of financial services firms. Already, in the House of Representatives, the Democrats are trying to frustrate Mr Trump’s deregulation agenda.
What do the bankers say?
Unsurprisingly, G-SIB chief executives are strongly against seeing their institutions broken up. Fortunately for them, Republican congressman Andy Barr gave them an opportunity to make their case when he asked what the US would be like without its G-SIBs.
Their answer was that it would be harder for giant US corporations to be supported, forcing them to rely on foreign G-SIBs instead. Such is the size of the world’s largest companies that only the largest banks can realistically support them – particularly when it comes to doing business globally. Another reason to keep the G-SIBs intact is the economies of scale that come from their size, and the breadth of often complementary services that can be offered under one roof.
Some of the CEOs also pointed to the support they give to smaller US companies, with billions of dollars of loans outstanding to the sector, as well as the support they give these companies when doing business abroad.
Will it provide the incentives?
Should the Democrats win 2020’s presidential elections, it does not automatically follow that the eight US G-SIBs will be broken up. Not all Democrats support such a move and some prefer them to be tightly regulated instead, as they consider them useful to the US economy and US interests.
Additionally, breaking up big banks does not rule out the occurrence of another severe banking crisis. Bigger, more robustly capitalised institutions often have the ability to better weather big financial storms thanks to asset, business and geographic diversification. It is also easier for supervisors to scrutinise a few big institutions rather than many thousands of smaller banks. What is more likely to transpire is a tighter reinterpretation of Dodd Frank rather than a dismantling of the G-SIBs.
And as Ms Waters noted during the hearings, despite bankers complaining about aspects of Dodd-Frank, they are still making hefty profits; in her mind the US regulatory regime is working just fine and does not need deregulation.
So Democrats could focus on capital size thresholds that decide where certain rules kick in. These could once again be lowered, catching out more banks. The Volcker rule (which restricts certain types of bank proprietary trading and is much disliked by the G-SIBs) could also be retuned to make such activities even more difficult. The stress tests could become even more rigorous, with the US supervisors returning to being less transparent about their thinking, to keep the G-SIBs on their toes.
If a more radical Democrat administration were to take over in 2021, it seems the G-SIBs could end up looking back on the past few years as their glory days.
